Tax credits for tuition growing rapidly

Submitted by Libby A. Nelson on November 16, 2011 - 3:00am

WASHINGTON -- One federal effort to make college more affordable cost almost $15 billion in 2009. Almost half of its benefits went to families making more than $75,000 per year. Yet as potential budget cuts hover over many financial aid programs, this one is left unmentioned.

The difference: the benefits are distributed through the tax code, not the financial aid office.

When the American Opportunity Tax Credit took effect in 2009, the tax savings claimed by students and families for college expenses more than doubled, climbing from $6.6 billion to $14.7 billion, according to the College Board’s Trends in Student Aid 2011 report[1] last month.

As the “super committee” for deficit reduction studies revenue and spending, and the budgets tighten for Education Department financial aid programs, the question is whether the tax credits will continue to escape unscathed.

“It’s sort of like the third part of the budget,” said Jason Delisle, director of the New America Foundation’s Federal Education Budget Project. “You’ve got the tax part, you’ve got the spending part, and then you’ve got the tax spending part.”

The credits have many fans, including middle- and upper-middle-class families who are ineligible for Pell Grants, subsidized loans and other traditional forms of federal financial aid. Compared to other tax expenditures, such as the $484 billion mortgage interest deduction, the tuition credits and deductions are relatively small.

Still, others question whether that $15 billion could be better used, whether for deficit reduction in lieu of Pell cuts or to better target aid to low-income families.

“Rather than thinking about them totally separately, we should be thinking about who are the students who are getting the subsidies,” said Sandy Baum, a financial aid policy analyst. “We should have less of a bright line between the tax credits and the grants.”

The American Opportunity Tax Credit, which consolidated and expanded tax breaks for college expenses that were established during the Clinton administration, gives taxpayers with an adjusted gross income of up to $180,000 a credit of up to $2,500 for tuition, fees and course expenses. Unlike previous tax credits, it is refundable: filers who do not owe taxes can receive a maximum refund of $1,000.

The previous, nonrefundable tax credits overwhelmingly benefited families at the middle of the income range or above, because only families with tax liabilities were eligible to benefit -- a frequent criticism of the program. In 2008, the last year before the new tax credit took effect, only 5 percent of savings went to families with an an adjusted gross income of less than $25,000, while 18 percent went to those making more than $100,000. The refundable credit was intended to address those concerns, and the share of low-income families who benefited from the tax credit grew substantially.

Still, even with the refundable credit, the highest savings went to those making more than $100,000 in adjusted gross income, and the highest earners' share of tax savings grew as well. In 2009, 17 percent of recipients were filers making less than $25,000 in adjusted gross income (whether because they had low wages or because they could almost eliminate their tax liabilities through other deductions). But the share of the savings going to families in the middle quintiles -- those with adjusted gross incomes between $25,000 and $50,000; $50,000 and $75,000; and $75,000 and $100,000 -- all dropped, and families making at least $100,000 received 26 percent of the savings.

The students whose families qualify for the tax credit frequently are ineligible for other kinds of federal and institutional aid, particularly if their test scores and grades aren’t high enough to qualify for academic scholarships, said Claude Pressnell, president of the Tennessee Independent Colleges and Universities Association and a former member of the federal Advisory Committee on Student Financial Assistance.

“This is one of the few benefits that reaches up into the middle income range of families, which I think is a benefit,” he said. “It appears to be targeting the right population -- a population that is grossly underserved by other aid programs.”

But tax credits have not been proven to affect whether students enroll or persist in college. Because taxpayers have to wait until the next calendar year to receive any benefit, tax credits are unlikely to be a deciding factor in getting people to go to college, Baum said.

“What it is for the middle class is extra money to make sure they can have a vacation that year, or they can buy another TV, or a nicer car,” said Sara Goldrick-Rab, an associate professor of educational policy studies and sociology at the University of Wisconsin at Madison who has studied the impact of financial aid programs on student enrollment and persistence. “It is not for putting food on the table, and it’s not paying the heating bill, and it’s not deciding whether or not the kid goes to college.”

So far, the tax breaks have escaped notice because governmental policies and public perception view grants and tax credits as separate entities, rather than essentially similar, Delisle said.

Unlike outlays for Pell Grants and other programs, tax credits are not handled by either the Education Department or the Congressional appropriations committees. Federal financial aid eligibility is based on the “estimated family contribution” from the Free Application for Federal Student Aid; eligibility for the tax credit is based on adjusted gross income. And to taxpayers, a tax credit is a way to keep money they would otherwise owe the government, while a grant program provides a more immediately tangible benefit: a check.

Still, tax credits function basically like grant programs: they take away money that would otherwise be used for other government priorities and redirect it to certain areas (such as college tuition costs). A grant program would be a more logical way to provide that benefit, in part because students would get the money up front, but it would be politically unacceptable to propose grants for families making up to $180,000 per year, Delisle said.

“It’s acceptable to everyone that you can provide tax breaks to middle class people and even higher income earners for tuition assistance,” Delisle said. “But you can’t do grants.”

Some changes to the program could make its benefits more visible to taxpayers, such as a box on the FAFSA notifying families who will not receive grant aid that they might still be eligible for the tax deduction, Pressnell said. But it is likely to remain a largely invisible program.

Congress extended the American Opportunity Tax Credit through 2012, at a cost of about $13 billion per year. The “super committee” on deficit reduction is said to be considering both spending and revenue changes in order to reduce the nation’s short-term debt, but any change to the tax credit is more likely to come as part of a larger tax reform bill, Delisle said.